In our update last week we talked about some deterioration in the market internals which was cause for concern. Ideally enough last week began in the red, we also talked about a potential support zone in the 1605-1597 area with confluence of a 50 day moving average, trend line support and a previous swing high all in the vicinity. Sure enough we tested that support level by Thursday and then proceeded to rally all the way through Friday on some seemingly good economic data in the NFP payroll report.
Now I'm still not quite convinced that the drop from 1685 is over quite yet. We put in what is the biggest correction in size since the November 2012 low, along with a lower low to go along with the lower high. So far the retracement even in light of Friday's strong move upwards, is still in the vicinity of 40 points, which is approximately the same size of the last retracement rally that produced the lower high. So even though Friday's price action was good, it doesn't necessarily mean the demand has overwhelmed just yet. Ideally you would like to see a push above that last lower high to break the pattern, and buy the pullback.
If that were to happen I would abandon any continuation to the downside theory and look to trade into upside targets. What are those upside targets?
This chart above points out what I believe are the most logical upside targets. There have been alternating 7% and 9% rallies off the swing lows since the November 2012 low was formed. The swing high at 1685 produced the second of the two 9% rallies. Another rally in the 7% range would take the S+P 500 up to around 1720-1725. And a rally up to 1750 would match the same size of the rally that took us to the 1685 high (150 pts). Giving us two logical and attainable points of reference going forward.
Now I always like to be ready and prepared for all scenarios. The chart below depicts what I believe to be the most logical outcome on a failure to take out that lower high on the S+P.
A failure to take out 1674 would result in an equal sized drop to a new lower low. My best estimation for the next stop lower would be in the vicinity of 1530-1550 on the S+P. You have the 2000 bull market high as support and if you look at the size of the corrections since the 2011 low was formed, they have all come in around the 130-150 pts in length.
Let's take a look at the Dow Industrial Average now, I've referenced this chart above in a previous long term market update post. I believe a correction of about 20% will start in the vicinity of that upside target, if not sooner.
Taking a closer look at the Dow chart we see two equal sized rallies of about 7.5% each. Another equal sized rally from Thursday's low would yield us getting around the 16,000 level and possibly pushing a little higher into our resistance zone above.
So I've outlined the two different scenarios and possible outcomes. My inclination is that we get that last push lower into support below, but will not hesitate to abandon my thesis on demand follow through. Being able to stay flexible is vitally important to long term success.